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Is African Bank ‘too big to fail’?

‘We’re monitoring the situation closely.’ – Reserve Bank

JOHANNESBURG – A failure by African Bank (Abil) could be systemic, due to the size of its loan book and the exposure of other financial institutions to its debt instruments, analysts have said, following the 60% drop in the troubled lender’s share price on news that it expects to lose billions in bad debt.

Abil issued a Sens announcement on Wednesday to the effect that it expects a headline loss of at least R6.4 billion for the full year to September 30. Its banking unit expects a basic and headline loss of at least R4.6 billion for the full year, with the retail unit, Ellerine Holdings, forecasting a headline loss of at least R1.7 billion.

The unsecured lender also announced the resignation of Group CEO, Leon Kirkinis, who had served 23 years in the business. It said it needed to raise at least R8.5 billion in order to meet minimum tier 1 capital requirements.

The news rocked the market, in a widespread sell-off that saw the share plummet to as low as R2.39 in early morning trade, losing upward of 64%. It was trading 57% lower at 13:50, at R2.95 a share, with more than 63 million shares having traded.

Head of research at brokerage Imara SP Reid, Stephen Meintjies described the market sell-off as “rational”, driven by huge fears of earnings dilution.

While it’s not clear whether capital upwards of R8.5 billion will be raised through a rights issue, it seems to be widely accepted that this is what Abil is proposing. Analysts are divided over whether shareholders will stomach yet another rights issue just months after the R5.5 billion capital raise they funded at the end of last year.

Sean Ashton, chief investment officer at Anchor Capital, said shareholders were in a very difficult position, as if they didn’t support a capital raise their investment would fall to zero. However, supporting the rights issue could mean “throwing good money after bad” and not eventually benefiting from decent return on capital in the long run.

Any rights issue, Ashton said, would have to be deeply discounted at R2 or less a share.

Meintjies believes Abil will raise the capital and turn a corner, while Jean Pierre Verster of 36 ONE Asset Management is doubtful that shareholders have the appetite. Refusal by shareholders to hand over the cash could leave the troubled lender going cap in hand to the South African Reserve Bank (Sarb).

“I don’t think the Reserve Bank will want Abil to fall over,” commented Ashton, who believes an Abil failure would be systemic in terms of the size of the loans in the market and the exposure of other banks to Abil’s debt instruments.

In a statement on its website, the Sarb said that measures to resolve Abil’s challenges “were currently under discussion”. “South Africa’s banking sector remains healthy and robust, and there have been no indications that other South African banks have been affected negatively by Abil’s trading update,” the statement said.

Investec Asset Management, Momentum Asset Management and Nedbank Capital are among the local institutions effectively funding the loans (as bondholders) that Abil advances to customers. At March 31, Abil had R55 billion of short- and long-term debt funding.

The Sarb said Abil’s “unique business model” was “unusually vulnerable” to a challenging business environment, since it did not enjoy the benefit of diverse income streams and transactional banking. “The Sarb continues to monitor Abil’s situation closely, and to engage with its board and senior management in search of viable long term solutions,” the Bank said.

With gross loans at R60 billion at the end of March, Jean Pierre Verster of 36ONE Asset Management said it would be a “moral hazard” if Abil went under. For the Reserve Bank to allow this to happen would be tantamount to telling people they don’t need to repay their loans, Verster said.

Additional risk was added by the debt exposure that local financial services firms had to Abil, which could see money market funds break the rand for the first time in South Africa, Verster said. “Money market funds could break the rand if Abil was no longer in a position to service the debt instruments previously issued, which would effectively result in investors getting less than the sight value of debt instruments,” Verster explained.

In other words, if you had R100 in a bank’s money market fund that had significant exposure to Abil, it would be worth less.

Tracy Brodziak of Old Mutual Equities was unsure whether the Reserve Bank would step in, pointing out that Abil didn’t have any retail depositors and that loan collections would be enforced regardless of what happened to the lender.

On Kirkinis’s resignation, Brodziak said she foresees further management changes. “You can’t be a part of the team that caused the problem,” she said. Meintjies said that someone had to carry the can for the weak performance. “In terms of the rules of the game, he [Kirkinis] just has to go.”

Ashton added Kirkinis’s credibility had taken a knock, since he had said fairly recently, at Abil’s half-year results, said that the bank was adequately capitalised and shareholders shouldn’t expect a rights issue.

Moneyweb awaits comment from the three companies with debt exposure to Abil.

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